China tech crackdown: Beijing’s soft touch on tax for Big Tech is set to end as it seeks more focus on science
- Beijing’s move to levy higher tax on internet companies would be the latest in a series of steps taken to rein in Big Tech in the country
- Regulators want to tighten qualification standard for so-called ‘key software enterprises’, making it harder for internet firms to enjoy tax reductions
Beijing is set to roll back tax incentives for software companies in favour of hard tech research and development, a policy change that may cast a shadow over the earnings prospects of companies such as e-commerce titan Alibaba Group Holding and internet giant Tencent Holdings.
Chinese media Caixin reported on Wednesday, citing unidentified tax officials, that Chinese regulators are looking to tighten the qualification standard for so-called “key software enterprises”, by introducing more stringent requirements for internet firms to enjoy tax reductions.
This comes after Alibaba, owner of the South China Morning Post, told investors in a call that the years-long government tax breaks the internet industry has enjoyed may soon begin to fade, as reported by Bloomberg last Friday. Separately, the Securities Times, a newspaper affiliated with the People’s Daily, reported last week that China should increase taxes on gaming companies.
“The tax environment will likely tighten for Big Tech in the future, or specifically big internet platforms,” said Pei Bo, senior equity research analyst at investment bank Oppenheimer.
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Beijing’s move to levy higher tax on internet companies would be the latest in a series of steps taken to rein in Big Tech in the country, and to direct more investment into “hard tech” areas like semiconductors and operation systems, as its tech rivalry with the US heats up.
In April, the Ministry of Industry and Information Technology along with three other departments in Beijing published guidelines for software enterprises, which should be “encouraged”. Those guidelines, Caixin reported, will also help to frame what can be classed as new “key software enterprises”, a designation that confers a preferential 10 per cent tax rate.
The April guidelines state that qualified companies must possess “core critical technologies” and conduct business based with them. The companies’ business or products also need to have their own patents or intellectual property.
In terms of personnel, the guidelines stipulate that companies must have at least 40 per cent of their employees with a bachelor‘s degree or higher. Furthermore, research and development (R&D) professionals need to account for at least 25 per cent of the total headcount.
The research and development spend of qualifying companies must also account for more than 7 per cent of total revenue as opposed to the traditional 6 per cent. Income related to software product development should account for at least 55 per cent of revenue from a previous 50 per cent.
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Pei said that Beijing is not looking to exclude or include candidates by sector, rather it wants to examine each company’s business model and their technology.
Alibaba has predicted an effective tax rate of 20 per cent for the September quarter, more than double from 8 per cent a year ago, according to the Bloomberg report. Alibaba also warned that most internet companies will likely no longer enjoy the 10 per cent rate.
Ming Liao, Beijing-based founder of Prospect Avenue Capital, an investment fund that manages US$500 million of assets, expects this new change to impact many sectors and companies although the spotlight may fall on a few internet platform companies.
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Liao urged better communication between Chinese regulatory institutions and investors. “We need better communication, of which the first step is to establish consistent and regular communication channels.”
In a note to clients, Gary Yu, an equity analyst at Morgan Stanley, said that he expects a minus 6 per cent negative earnings per share impact on Tencent, which is the world’s largest gaming company, assuming Tencent’s enterprise income tax rate goes up from 10 per cent to 15 per cent. Yu said the worst case scenario would be for the tax rate to soar to 25 per cent.
Yu expects effective tax rates for NetEase, China’s second-largest gaming company, to rise from last year’s 20 per cent to as much as 25 per cent between 2021 and 2023.
